What Are Monetary Aggregates?

What Are Monetary Aggregates?

Let me explain monetary aggregates to you directly: they're the various ways we measure the money supply in an economy. In the United States, we use them to gauge the nation's economic health and stability. Plus, the Federal Reserve relies on them to carry out its monetary policy.

Here in the U.S., we label these aggregates as follows. M0 is paper money and coin currency in circulation, plus bank reserves held by the central bank; you might hear it called the monetary base. M1 includes currency held by the public and transaction deposits like checking account balances at U.S. depository institutions and foreign bank branches operating in the U.S., plus traveler’s checks. M2 covers all of M1, plus money market shares and savings deposits in amounts less than $100,000.

There's also a legacy aggregate called M3, which is all of M2 plus large time deposits over $100,000, institutional money market funds, repo agreements, and large liquid assets. The Federal Reserve stopped tracking it officially in 2006, but some analysts still calculate it.

Key Takeaways

A monetary aggregate is simply a formal method to account for money, including cash or money market funds. These aggregates measure the money supply in a national economy. The monetary base includes the total supply of currency in circulation plus the stored portion of commercial bank reserves within the central bank. The Federal Reserve uses money aggregates as a metric to see how open-market operations affect the economy.

Understanding Monetary Aggregates

The monetary base, or M0, isn't something we observe widely, but it's crucial even if it differs from the overall money supply. It covers the total supply of currency in circulation plus the stored portion of commercial bank reserves within the central bank. We sometimes call this high-powered money because it can multiply through fractional reserve banking.

M1 is a narrow measure of the money supply that includes physical currency, demand deposits, traveler’s checks, and other checkable deposits. M2 calculates the money supply by including all elements of M1 plus 'near money,' which refers to savings deposits, money market securities, mutual funds, and other time deposits. These assets are less liquid than M1 and not as suitable for exchanges, but you can convert them into cash or checking deposits quickly.

How They’re Used

The Federal Reserve uses monetary aggregates as a metric for how open-market operations, such as trading in Treasury securities or changing the discount rate, impact the economy. Investors and economists watch these aggregates closely to predict what actions the Fed might take. They provide a more accurate picture of the actual size of a country’s working money supply.

By reviewing weekly reports of M1 and M2 data, you can measure the rate of change in monetary aggregates and overall monetary velocity. This can give you an idea of whether the Fed might raise or lower interest rates. As of May 2024, the U.S. monetary base stands at $5.725 trillion.

The Impact of Monetary Aggregates

Studying monetary aggregates gives you substantial information on a country's financial stability and overall health. For instance, if aggregates grow too rapidly, it may raise concerns about increasing inflation. If there's more money in circulation than needed for the same goods and services, prices are likely to rise. If inflation spikes, central banks may need to raise interest rates or halt money supply growth.

For decades, these aggregates were essential for understanding a nation’s economy and setting central banking policies. But in the past few decades, we've seen less connection between money supply fluctuations and key metrics like inflation, GDP, and unemployment. Still, the amount of money the Fed releases indicates its monetary policy clearly. When compared with GDP growth, M2 remains a useful indicator of potential inflation.

Importantly, the M2 money supply contracted 4.1% from $21.7 trillion in July 2022 to $20.8 trillion in May 2023, dropping further to $20.75 trillion in February 2024.

Example

Since 2022, the U.S. money supply has seen a reduction greater than any since World War II. Such reductions aren't common, and when they happen, they can signal upcoming problems with economic growth, employment, and inflation. An M2 that isn’t growing could presage a recession, rising unemployment, and deflation. However, GDP growth in the fourth quarter of 2023 increased by 3.2%, which surpassed expectations and was viewed as positive by the Biden administration.

Why Are Monetary Aggregates Important?

They matter to the Fed, policymakers, economists, and investors because they can signal potential slowing economic growth, inflation, deflation, unemployment, and recession.

When Did the Fed Start Reporting Monthly Data on Monetary Aggregates?

In 1944, the Fed began releasing monthly reports on what became the M1 aggregate. In 1971, it added monthly reports for M2 and M3.

Where Do We Find Data on Our Monetary Aggregates?

The Fed releases the Money Stock Measures—H.6 Release on the fourth Tuesday of every month. It shows the latest and past figures for the monetary base, M1, and M2.

The Bottom Line

Monetary aggregates measure a nation’s money supply. In the U.S., we study the monetary base (M0), M1, and M2. They provide insight into the economic health and well-being of a nation and the stability of its financial markets.

Correction—July 20, 2024: This article has been corrected to state that the M1 monetary aggregate contains currency held by the public and transaction deposits at U.S. depository institutions and foreign bank branches operating in the U.S., plus traveler’s checks.